Chapter 16

Maximizes the value of the firm.

A firm should select the capital structure that: Produces the highest cost of capital. Maximizes the value of the firm. Minimizes taxes. Is fully unlevered. Equates the value of debt with the value of equity.

An all-equity firm.

The unlevered cost of capital refers to the cost of capital for: A privately owned entity. An all-equity firm. A governmental entity. A private individual. A corporate shareholder.

Decreases as the debt-equity ratio increases.

Based on M&M Proposition I with taxes, the weighted average cost of capital: Is equal to the aftertax cost of debt. Has a linear relationship with the cost of equity capital. Is unaffected by the tax rate. Decreases as the debt-equity ratio increases. Is equal to RU ×(1 - TC).

TC ×D.

The present value of the interest tax shield is expressed as: (TC ×D) / RA.. VU + (TC ×D). [EBIT ×(TC ×D)] / RU. [EBIT ×(TC ×D)] / RA. TC ×D.

Reorganization.

Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business. The process this firm underwent is known as a: Merger. Repurchase program. Liquidation. Reorganization. Divestiture.

Dependent upon a firm's capital structure.

Financial risk is: The risk inherent in a firm's operations. A type of unsystematic risk. Inversely related to the cost of equity. Dependent upon a firm's capital structure. Irrelevant to the value of a firm.

The use of personal borrowing to alter the individual's degree of financial leverage

Homemade leverage is:

Value of the levered firm will exceed the value of the firm if it were unlevered.

If a firm has the optimal amount of debt, then the: Direct financial distress costs must equal the present value of the interest tax shield. Value of the levered firm will exceed the value of the firm if it were unlevered. Value of the firm is minimized. Value of the firm is equal to VL + TC ×D. Debt-equity ratio is equal to 1.

The debt-equity ratio of a firm is completely irrelevant.

M&M Proposition I with no tax supports the argument that: Business risk has no effect on the return on assets. The cost of equity rises as leverage rises. The debt-equity ratio of a firm is completely irrelevant. Business risk is irrelevant. Homemade leverage is irrelevant.

A firm's cost of equity is a linear function with a slope equal to (RA - RD).

M&M Proposition II, without taxes, is the proposition that: The capital structure of a firm has no effect on the firm's value. The cost of equity depends on the return on debt, the debt-equity ratio, and the tax rate. A firm's cost of equity is a linear function with a slope equal to (RA - RD). The cost of equity is equivalent to the required rate of return on a firm's assets. The size of the pie does not depend on how the pie is sliced.

Which parties receive payment first in a bankruptcy proceeding.

The absolute priority rule determines: When a firm must be declared officially bankrupt. How a distressed firm is reorganized. Which judge is assigned to a particular bankruptcy case. How long a reorganized firm is allowed to remain under bankruptcy protection. Which parties receive payment first in a bankruptcy proceeding.

Has a positive relationship with the firm's cost of equity.

The business risk of a firm: Depends on the firm's level of unsystematic risk. Is inversely related to the required return on the firm's assets. Is dependent upon the relative weights of the debt and equity used to finance the firm. Has a positive relationship with the firm's cost of equity. Has no relationship with the required return on a firm's assets according to M&M theory.

Minimizes the cost of capital.

The capital structure that maximizes the value of a firm also: Minimizes financial distress costs. Minimizes the cost of capital. Maximizes the present value of the tax shield on debt. Maximizes the value of the debt. Maximizes the present value of the bankruptcy costs.

M&M Proposition I with no tax.

The concept of homemade leverage is most associated with: M&M Proposition I with no tax. M&M Proposition II with no tax. M&M Proposition I with tax. M&M Proposition II with tax. The static theory proposition.

Indirect bankruptcy

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs. Flotation Direct bankruptcy Indirect bankruptcy Financial solvency Capital structure

Direct bankruptcy

The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as _____ costs. Flotation Issue Direct bankruptcy Indirect bankruptcy Unlevered

Debt-equity ratio results in the lowest possible weighted average cost of capital.

The optimal capital structure has been achieved when the: Debt-equity ratio is equal to 1. Weight of equity is equal to the weight of debt. Cost of equity is maximized given a pretax cost of debt. Debt-equity ratio is such that the cost of debt exceeds the cost of equity. Debt-equity ratio results in the lowest possible weighted average cost of capital.

The static theory of capital structure.

The proposition that a firm borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs is called: The static theory of capital structure. M&M Proposition I, with taxes. M&M Proposition II, with taxes. The pecking-order theory. The open markets theorem.

Weighted average cost of capital is minimized.

The value of a firm is maximized when the: Cost of equity is maximized. Tax rate is zero. Levered cost of capital is maximized. Weighted average cost of capital is minimized. Debt-equity ratio is minimized.

180 days

Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, how long after a firm files for bankruptcy protection do creditors have to wait before submitting their own reorganization plan to the court?

Interest tax shield

Westover Mills reduced its taxes last year by $680 by increasing its interest expense by $2,000. Which one of the following terms is used to describe this tax savings? Interest tax shield Interest credit Homemade leverage shield Current tax yield Tax-loss interest

Paying an outside accountant to prepare bankruptcy reports.

Which one of the following is a direct cost of bankruptcy? Bypassing a positive NPV project to avoid additional debt. Firm investing in cash reserves. Maintaining a debt-equity ratio that is lower than the optimal ratio. Losing a key company employee. Paying an outside accountant to prepare bankruptcy reports.

Principal payment on long-term debt.

Which one of the following is a marketed claim against a firm's cash flows?

Financial

Which one of the following is the equity risk related to a firm's capital structure policy? Market Systematic Static Business Financial

Business risk

Which one of the following is the equity risk that is most related to the daily operations of a firm?

The required return on assets is equal to the weighted average cost of capital.

Which one of the following statements is correct in relation to M&M Proposition II, without taxes? The cost of equity remains constant as the debt-equity ratio increases. The cost of equity is inversely related to the debt-equity ratio. The required return on assets is equal to the weighted average cost of capital. Financial risk determines the return on assets. Financial risk is unaffected by the debt-equity ratio.

M&M Proposition II

Which one of the following states that a firm's cost of equity capital is directly and proportionally related to the firm's capital structure?

Filing proofs of claim.

Which one of these actions generally occurs first in a bankruptcy reorganization?

The optimal capital structure maximizes shareholder value.

Which one of these statements is correct?

Firm is earning just enough to pay for the cost of the debt.

You have computed the break-even point between a levered and an unlevered capital structure. Ignore taxes. At the break-even level, the: Firm is earning just enough to pay for the cost of the debt. Firm's earnings before interest and taxes are equal to zero. Earnings per share for the levered option are exactly double those of the unlevered option. Advantages of leverage exceed the disadvantages of leverage. Firm has a debt-equity ratio of .50.